Food and Drug
`
`Law Journal
`
`Analyzing the Laws, Regulations, and Policies
`Affecting FDA-Regulated Products
`
`Does Generic Entry Always
`Increase Consumer Welfare?
`
`Henry Grabowski, Tracy Lewis,
`Rahul Guha, Zoya Ivanova,
`Maria Salgado, and Sally Woodhouse
`
`FDLI
`
`Volume 67 Number 3 2012
`
`AstraZeneca Exhibit 2146
`Mylan v. AstraZeneca
`IPR2015-01340
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`Does Generic Entry Always
`Increase Consumer Welfare?
`
`HEnry GraBOwski, tracy LEwis, raHUL GUHa,
`ZOya iVanOVa, Maria saLGaDO, anD saLLy wOODHOUsE*
`
`This article examines how the nature of competition between brands in a therapeutic
`category changes after generic entry and provides a framework for analyzing the effect
`of generic entry on consumer welfare that takes into account the generic free riding
`problem. It demonstrates that changes in competition along dimensions other than retail
`price – such as competition in research and development efforts and in promotional
`activities – may, in certain situations, result in generic entry having an overall negative
`impact on consumer welfare.
`
`intrODUctiOn
`i.
`The U.S. Court of Appeals for the Third Circuit recently ruled that so-called “re-
`verse payment” settlements of patent infringement litigation between a branded drug
`manufacturer and potential generic competitors are presumptively anticompetitive.1 In
`such settlements, the branded and generic drug manufacturers settle on a date of generic
`entry, a date that is often well before the expiration of the patent(s) at issue, and at the
`same time the branded manufacturer makes a payment to the generic manufacturer.
`The Third Circuit decision stands in stark contrast to rulings by the Appeals Courts in
`the Federal, Second, and Eleventh Circuits that such settlements are legal as long as
`the patent infringement litigation was not a sham and any restrictions on the generic
`company’s marketing of a generic drug do not exceed the scope of the patent(s) at issue.2
`The Third Circuit ruling shifts the burden to defendants to show that such agreements
`are not anticompetitive. As a result, analyses of the competitive effects of such agree-
`ments will be more important, at least in the Third Circuit, and potentially nationally
`if the U.S. Supreme Court hears the case and upholds the Third Circuit’s decision.3
`The Third Circuit decision represents a substantial victory for the Federal Trade Com-
`mission (FTC) which has focused significant attention on the potential anticompetitive
`harm arising from “reverse payment” settlements.4 The FTC has long argued that such
`settlements delay generic entry because absent a “reverse payment” the settling parties
`* Henry Grabowski , Department of Economics, Duke University; Tracy Lewis, The Fuqua School of
`Business, Duke University; Rahul Guha, Zoya Ivanova, Maria Salgado, and Sally Woodhouse, Cornerstone
`Research. The views expressed in this article are those of the authors only and do not necessarily represent
`the views of Cornerstone Research or Duke University.
`In Re: K-Dur Antitrust Litigation, Nos. 10-2077, 10-2078 and 10-2079 (3d Cir. 2012). The U.S.
`1
`Court of Appeals for the Third Circuit has federal jurisdiction over Delaware, New Jersey, and Pennsylvania.
`In Re: Ciprofloxacin Hydrochloride Antitrust Litigation, No. 2008-1097 (Fed. Cir. 2008); In Re:
`2
`Tamoxifen Citrate Antitrust Litigation, 466 F.3d 187 (2006); In Re: Ciprofloxacin Hydrochloride Antitrust
`Litigation, 05-2851-cv(L) and 05-2852-cv(CON) (2d Cir. 2010); Federal Trade Commission v. Watson
`Pharmaceuticals Inc., No. 10-12729 (11th Cir. 2012).
`3 Given the conflicting rulings across the different Circuit Courts, the issue is ripe for review by the
`U.S. Supreme Court and Merck, the defendant in the Third Circuit case, has already petitioned the Supreme
`Court. Merck & Co. v. Louisiana Wholesale Drug Co., Inc., U.S., No. 12-245, petition for cert. filed 8/24/12.
`At least one set of reverse payment cases was put on hold by a lower court while the Supreme Court decides
`whether to hear the K-Dur case and resolve the conflicting Circuit Court rulings. Federal Trade Commission
`v. Cephalon, Inc., No. 2:08-cv-2141 (Opinion, E.D. of Penn. 2012).
`In addition to the FTC, the US Department of Justice, and the European Commission have all raised
`4
`concerns about “reverse payment” settlements.
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`would agree on an earlier generic entry date. While there has been much debate as to
`whether earlier entry would occur absent “reverse payment” settlements, little atten-
`tion has been paid as to whether earlier entry will actually increase consumer welfare.
`Instead, it has been presumed that generic competition enhances consumer welfare
`because when generics enter the market, drug prices fall as patients switch from high-
`priced branded drugs to lower-priced, therapeutically equivalent generics.
`The effect of generic competition on consumer welfare is not always clear cut, how-
`ever. In particular, generic competition reduces the incentives of brand manufacturers
`to inform physicians about the benefits of their drugs, provide price discounts in the
`form of free samples, and to enhance the usefulness of their drugs by seeking approval
`for additional indications. The reduced incentives to engage in such activities occur
`because generic manufacturers are able to “free ride” on brand manufacturers’ promo-
`tional and research and development (R&D) efforts essentially capturing the benefits
`of those efforts instead of the brand manufacturer.5 Promotional and R&D activities
`represent a major form of competition between branded therapeutic alternatives and
`generic entry can have the effect of decreasing such competition and thereby reducing
`the welfare benefits of generic competition to consumers.
`Though certainly not always the case, the ability of generic manufacturers to free
`ride on the promotional and R&D efforts of brand manufacturers can result in situa-
`tions where generic entry reduces consumer welfare on net. Indeed, recent academic
`research has demonstrated that generic competition frequently results in a reduction in
`prescriptions—a surprising result if generic entry were always procompetitive.6
`An analysis of whether generic entry is likely to enhance or diminish consumer wel-
`fare requires an examination of the market within which the brand competes—i.e., the
`therapeutic category—and an understanding of how the nature of competition between
`brands in the category is likely to change with generic entry. This article provides a
`framework for analyzing the consumer welfare effects of generic competition to take
`into account the effect free riding by generics has on brand manufacturers’ incentives
`to compete along dimensions other than price.7
`The next section of this article discusses the factors that are important in assessing
`consumer welfare in pharmaceutical markets. Section III discusses the effect of generic
`entry on competition and consumer welfare. Section IV presents a case study in the
`5 Free riding often results in “destructive” or welfare decreasing competition, a form of competition
`that has long been noted as a potentially important defect of market systems. See Raymond Deneckere,
`Howard P. Marvel & James Peck, Demand Uncertainty, Inventories, and Resale Price Maintenance, 111
`Q. J. Econ. 885 (1996), for a discussion of destructive competition in manufacturing; Thomas W. Hazlett,
`Rivalrous Telecommunications Networks With and Without Mandatory Sharing, 58 Federal Communications
`Law Journal 3 (2006), for a discussion in telecommunications; Joseph E. Stiglitz, Private Uses of Public
`Interests: Incentives and Institutions, 12 J. Econ. Persp. 3 (1998), for a discussion in public finance and federal
`policy; Michael G. Jacobides, Mortgage Banking, Unbundling: Structure, Automation and Profit, Housing
`Fin. Int’l. (2002), for a discussion in financial markets; and Yannis Bakos & Erik Brynjolfsson, Aggregation
`and Disaggregation of Information Goods: Implications for Bundling, Site Licensing and Micropayment,
`Internet publishing and beyond: The Economics of Digital Information And Intellectual Property, (Deborah
`Hurley, Brian Kahim & Hal Varian, eds., MIT Press 1997), for a discussion in internet markets.
`6 See Darius Lakdawalla, Thomas Philipson & Richard Wang, Intellectual Property and Marketing
`(NBER, Working Paper No. 12577, 2006); Frank R. Lichtenberg & Gautier Duflos, Does Patent Protection
`Restrict U.S. Drug Use? The Impact of Patent Expiration on U.S. Drug Prices, Marketing, and Utilization,
`presented at Pharmaceutical Research Development and Markets conference, Harvard Law School, (June
`12-13, 2009); Ernst R. Berndt, Margaret K. Kyle & Davina C. Ling, The Long Shadow of Patent Expiration:
`Generic Entry and Rx-to-OTC switches, Scanner Data and Price Indexes, (Robert C. Feenstra & Matthew
`D. Shapiro, eds., 2003).
`7 While it can be argued that the relevant metric to assess whether a particular action is procompetitive
`is total welfare, we focus on consumer welfare in this article as it is the metric usually focused on by antitrust
`authorities.
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`oral contraceptive market to demonstrate the key economic trade-offs associated with
`generic entry. Section V describes the implications of this discussion for biologic drugs.
`Section VI concludes.
`
`ii. BEnEFits anD cOsts OF BranDED
`anD GEnEric DrUGs
`As a general matter, consumer welfare depends on the benefits of a product compared
`to its costs. With respect to pharmaceutical products, patients take drugs to prevent and
`treat the causes and/or symptoms of disease, illness, and other conditions. The ability
`of a drug to prevent or treat a condition is measured by its efficacy. Adverse reactions
`and interactions with other drugs or treatments affect the value of the drug as well.
`Convenience and ease of use—how frequently a drug needs to be taken, whether it
`must be taken with or without food, its form (e.g., pill, liquid, injection)—also affect
`a drug’s value to consumers.8
`A. Competitive Effects Of Pharmaceutical Promotion
`Safety and efficacy are largely the same for brand and generic versions of a drug. A
`major difference in value provided by brand and generic drugs is in the promotional
`activities undertaken by brand manufacturers. Because the primary decision makers in
`the prescribing process are physicians, most brand promotional efforts are directed at
`them. Promotional activities to physicians include detailing (presentations to physicians
`by a salesperson), advertising in medical journals, and the provision of free samples.
`Such promotion can inform physicians about new drugs or approvals for new indica-
`tions for existing drugs, increase awareness of the results of clinical studies, highlight
`differences between therapeutic competitors, and provide information on health insur-
`ance coverage.9 Detail visits also provide an opportunity for physicians to ask questions
`about the drug and its competitors. Free samples can have educational, compliance,
`and convenience benefits.10 Drug manufacturers also advertise directly to consumers
`which can encourage consumers to seek treatment and improve patient compliance.
`Economists have debated whether pharmaceutical advertising serves primarily an
`informational role or a persuasive role. If advertising is informational—i.e., it increases
`patient and physician awareness and knowledge of treatment options—it is welfare en-
`hancing. In contrast, persuasive advertising may be socially wasteful if its primary goal
`
`8 Economists have found that drug characteristics such as efficacy, side effects, number of drug in-
`teractions, and dosing frequency affect the value of a drug to consumers. See, for example, Ernst R. Berndt,
`Robert S. Pindyck & Pierre Azoulay, Consumption Externalities and Diffusion in Pharmaceutical Markets:
`Antiulcer Drugs, 51 J. Indus. Econ. 243 (2003). Ernst R. Berndt, Linda T. Bui, David H. Reiley & Glen L.
`Urban, Information, Marketing and Pricing in the U.S. Anti-Ulcer Drug Market, 85 Am. Econ. Rev. 100 (1995);
`Ernst R. Berndt, Ashoke Bhattacharjya, David Mishol, Almudena Arcelus & Thomas Lasky, An Analysis of
`the Diffusion of New Antidepressants: Variety, Quality, and Marketing Efforts, 5 J. Mental Health Pol’y &
`Econ. 3 (2003); Charles King, III, Marketing, Product Differentiation, and Competition in the Market for
`Antiulcer Drugs, (HBS, Working Paper, 2002); Sriram Venkataraman & Stefan Stremersch, The Debate on
`Influencing Doctors’ Decisions: Are Drug Characteristics the Missing Link? 53 Mgmt. Sci. 1688, (2007).
`9 See, for example, Füsun Gönül, Franklin Carter, Elina Petrova & Kannan Srinivasan, Promotion of
`Prescription Drugs and Its Impact on Physicians’ Choice Behavior, 65 J. Marketing 79 (2001); Sriram Ven-
`kataraman & Stefan Stremersch, The Debate on Influencing Doctors’ Decisions: Are Drug Characteristics the
`Missing Link? 53 Mgmt. Sci. 1688 (2007); and Kissan Joseph and Murali K. Mantrala (2003), “Prescription
`Drug Promotion: The Role & Value of Physicians’ Samples under Competition,” Working Paper.
`10 Samples can be used to demonstrate how to administer a drug and encourage patients to try a new
`alternative. Samples also offer added convenience to patients by eliminating the need for an immediate visit
`to the pharmacy. See Kissan Joseph and Murali K. Mantrala (2003), “Prescription Drug Promotion: The Role
`and Value of Physicians’ Samples under Competition,” Working Paper.
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`is to create “artificial” differentiation or to cause physicians to over-prescribe a particular
`brand. Researchers have generally categorized promotion that expands overall sales in
`a therapeutic category as informational and promotion that affects drug market shares
`within a therapeutic category as persuasive.11 However, to the extent that informative
`promotion helps physicians better match patients to drugs, promotion that affects drug
`market shares may also be informative. Similarly, if promotion results in overtreatment,
`promotion that expands the market may not necessarily be welfare enhancing.
`The evidence in support of pharmaceutical promotion being either persuasive or
`informative is mixed. In one of the earliest articles on the topic, Leffler (1981) found
`empirical evidence for both the informational and persuasive roles of advertising but
`emphasized the welfare enhancing role of advertising by noting that “product promotion
`has a significant positive effect on the entry success of therapeutically important new
`drugs.”12 Berndt et al. (1995) found evidence that pharmaceutical promotions affect
`both the market size and individual market shares of anti-ulcer drugs,13 providing evi-
`dence that pharmaceutical promotion may have both a persuasive and an informational
`role. Hurwitz and Caves (1988) found that pharmaceutical promotion helps to preserve
`brand share after generic entry and interpreted this as evidence of the persuasive role
`of advertising.14
`In contrast, Iizuka and Jin (2002) found that direct-to-consumer advertising encour-
`ages outpatient office visits but has no effect on the choice of a particular brand pre-
`scribed, and Rosenthal et al. (2003) found that both detailing and direct-to-consumer
`advertising have a market-expanding rather than business-stealing effect. Azoulay (2002)
`also noted that “much advertising refers explicitly to clinical results” and concluded that
`published clinical studies drive both detailing and journal advertising expenditures of
`pharmaceutical manufacturers. Gonul et al. (2001) concluded that competition that oc-
`curs among sales representatives detailing different drugs can reduce the persuasiveness
`of detailing for each given drug while making more objective information available to
`physicians.15 These four studies support the informational role of advertising.
`Narayanan et al. (2005) analyzed the temporal aspect of the role of promotion and
`found that, for new drugs, the informative role dominates initially in the product life
`cycle with the persuasive role taking over as the uncertainty about the drug’s efficacy
`is resolved.16 Narayanan and Manchanda (2009) found significant heterogeneity in the
`impact of detailing across physicians over time, implying that the rate of change of the
`dominant role of promotion (from informative to persuasive) varies among physicians
`and that for some physicians the informative value of promotion remains for a long
`period of time.17
`
`11 Keith B. Leffler, Persuasion or Information? The Economics of Prescription Drug Advertising, 24
`J.L. & Econ 45, (1981). See also Mark A. Hurwitz & Richard E. Caves, Persuasion or Information? Promo-
`tion and the Shares of Brand Name and Generic Pharmaceuticals, 31 J.L. & Econ. 299 (1988).
`12 Keith B. Leffler, Persuasion or Information? The Economics of Prescription Drug Advertising, 24
`J.L. & Econ. 45 (1981).
`13 Ernst R. Berndt, Linda Bui, David R. Reiley & Glen L. Urban, Information, Marketing, and Pricing
`in the U.S. Antiulcer Drug Market, 85 Am. Econ. Rev. 100 (1995).
`14 Mark A. Hurwitz & Richard E. Caves, Persuasion or Information? Promotion and the Shares of
`Brand Name and Generic Pharmaceuticals, 31 J.L. & Econ. 299 (1988).
`15 Füsun Gönül, Franklin Carter, Elina Petrova & Kannan Srinivasan, Promotion of Prescription Drugs
`and Its Impact on Physicians’ Choice Behavior, 65 J. Marketing 79 (2001).
`16 Narayanan, Sridhar, Puneet Manchanda & Pradeep Chintagunta, Temporal Differences in the Role
`of Marketing Communication in New Product Categories, 42 J. Marketing Res. 278 (2005).
`17 Sridhar Narayanan & Puneet Manchanda, Heterogeneous Learning and the Targeting of Marketing
`Communication for New Products, Marketing Sci. (2009).
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`Research has also focused on promotion’s role in matching patients to drugs. Bradford
`et al. (2005) found that the advertising for osteoarthritis drugs encouraged faster adoption
`among the patients who were good candidates for the treatment, and decreased the speed
`of adoption for less well-suited clinical candidates. Crawford and Shum (2005) showed
`that significant uncertainty exists in the idiosyncratic match between patients and drugs
`which is resolved through patients actually trying a drug.18 Joseph and Mantrala (2009)
`argued that free samples can reduce the cost of patients trying drugs, thereby making
`the process of matching drugs with patients easier and cheaper in an environment of
`uncertainty.19 Taken together, these studies support the view that promotional activities
`improve the matching process between patients and drugs.
`Academic research has also found that pharmaceutical promotion may increase
`patients’ compliance with treatment. Donohue et al. (2004) studied the effect of direct-
`to-consumer (DTC) advertising and detail visits on the initiation and duration of treat-
`ment for people diagnosed with depression.20 They found that an increase in aggregate
`DTC advertising for the antidepressant category beyond a certain threshold led to an
`increase in the duration of antidepressant use for patients.21 Calfee et al. (2002) found
`that DTC advertising is positively associated with the proportion of cholesterol patients
`who have been successfully treated, which may also indicate an improved compliance
`with treatment.22 Promotion may thus increase total consumer welfare both by increas-
`ing the value of pills consumed due to better matching and by increasing the quantity
`of the drug consumed through improved compliance and by encouraging patients to
`seek treatment.
`In contrast to the promotional efforts of brand manufacturers, generic manufacturers
`do not generally market their drugs to consumers or physicians. Instead, generic manu-
`facturers rely on physicians to write prescriptions for the branded product that are then
`substituted at the pharmacy with a generic version.23 Substitution laws enacted in each
`state either allow or mandate pharmacies to dispense generic equivalents in the place of
`branded drugs unless the brand is cheaper or such substitution is explicitly prohibited by
`the prescribing physician.24 When multiple generic versions are available, the pharma-
`cies choose which generic version to use. Because physicians and consumer have no
`control over which generic version is substituted for the brand, manufacturers have no
`incentive to promote generic drugs to physicians or consumers. As a result, the infor-
`mational and other benefits of promotion are provided solely by brand manufacturers.
`B. Incremental Innovation Through Supplementary Indications
`Branded drug companies also increase the value of pharmaceutical products by con-
`ducting clinical trials to gain regulatory approval for additional indications. Although
`
`18 Gregory Crawford & Matthew Shum, Uncertainty and Learning in Pharmaceutical Demand, 73
`Econometrica 1137 (2005).
`19 Kissan Joseph & Murali Mantrala, A Model of the Role of Free Drug Samples in Physicians’ Pre-
`scription Decisions, 20 Marketing Ltrs. 15 (2009).
`20 Julie M. Donohue, Ernst R. Berndt, Meredith Rosenthal, Arnold M. Epstein & Richard G. Frank,
`Effects of Pharmaceutical Promotion on Adherence to the Treatment Guidelines for Depression, 42 Med.
`Care 1176 (2004).
`21 The authors found that drug-specific DTC advertising did not have a statistically significant effect
`on the duration of use for that drug.
`22 John E. Calfee, Clifford Winston & Randolph Stempski, Direct-to-Consumer Advertising and the
`Demand for Cholesterol-Reducing Drugs, 45 J.L. & Econ. Pt. 2: The Regulation of Medical Innovation and
`Pharmaceutical Markets 673 (2002).
`23 This article focuses on self-administered drugs—drugs dispensed through pharmacies—rather than
`drugs that are administered by physicians during office or hospital visits.
`24 Physicians can prevent generic substitution by writing “dispense as written” on a prescription.
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`physicians can prescribe drugs for indications that are not approved by the Food and
`Drug Administration (FDA), clinical trials for new indications and resulting FDA ap-
`proval provide information to physicians about the drug’s efficacy and safety for those
`indications.25 Such efforts in turn increase the use of the drug for those indications and
`more consumers can benefit from the use of the drug.
`Berndt, Cockburn and Grepin (2006), among other researchers, have documented
`the significant benefits to patients from supplemental indications.26 For example, the
`proton pump inhibitors class of drug products, initially approved as anti-ulcer medi-
`cines, experienced greater patient utilization from their supplementary approval for
`gastroesophageal reflux disease. Products in the selective serotonin re-uptake inhibitors
`class of anti-depressants gained several supplementary indications for the treatment of
`associated mental disorders including panic disorder, obsessive compulsive disorder,
`bulimia nervosa, and generalized anxiety disorder. This pattern of incremental innova-
`tion through supplementary indications characterizes many major therapeutic classes
`and has resulted in significant economic and medical benefits.
`C. Price Competition By Generic And Brand Manufacturers
`The benefits of pharmaceutical products must be viewed in relation to their costs.
`The retail price—i.e., the total price charged by pharmacies including the patient’s
`out-of-pocket costs (the copayment for insured patients) and any payments made by
`third party payors—of a generic product is lower than the retail price of its branded
`counterpart. The extent of the retail price discount offered by generics depends on the
`degree of generic competition—i.e., the number of manufacturers offering a generic
`version of the drug. A 1998 Congressional Budget Office (CBO) study has estimated
`that in 1994 the average retail price of a generic prescription was half the price of a
`prescription filled with a branded drug for which generic versions were also available
`on the market. The same study showed an increase in the discount offered by generic
`competitors as the number of generics on the market grew.27 Reiffen and Ward (2005)
`estimated that with ten or more generic manufacturers, generic retail prices approach
`the cost of manufacturing and distributing a generic resulting in very low profit mar-
`gins.28 Grabowski and Vernon (1992) studied a sample of 18 drugs that experienced
`generic entry between 1983 and 1987 and had sales above $50 million per year at the
`time of patent expiration.29 They found that the average generic in this category offered
`a 39 percent retail price discount at the time of entry, and this discount increased to 54
`percent one year after entry, and to 63 percent two years after entry.
`For branded drugs, there are two other factors affecting price: rebates to third party
`payors (TPPs) and free samples. The size of discounts provided by rebates to TPPs is
`hard to quantify because such rebates are usually confidential. The 1998 CBO study
`estimated that the ratio of the best price (i.e., the lowest price to any private purchaser
`including TPPs) to the average price paid by wholesalers was on average equal to 0.77
`
`25 By law, pharmaceutical manufacturers can only market their drugs for the indications approved by
`the FDA.
`26 Ernst R. Berndt, Iain M. Cockburn, and Karen A. Grepin, The Impact of Incremental Innovation
`in Biopharmaceuticals: Drug Utilisation in Original and Supplemental Indication, PHARmACOECOnOmICS 69
`(2005).
`27 How Increased Competition from Generic Drugs Has Affected Prices and Returns in the Pharma-
`ceutical Industry, Congressional Budget Office, July 1998, at 33.
`28 David Reiffen & Michael R. Ward, Generic Drug Industry Dynamic, 87 Rev. Econ & Stat. 37, (2005).
`29 Henry G. Grabowski & John M. Vernon, Brand Loyalty, Entry and Price Competition in Pharma-
`ceuticals After the 1984 Drug Act, 35 J.L. & Econ 331 (1992).
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`in 1994, and for some drugs reached as low as 0.10.30 This suggests that rebates can
`provide significant price discounts. The FTC also conducted a survey of private TPPs
`and estimated that the average rebate per brand drug prescription was $5.22 in 2002 and
`increased to $6.34 in 2003.31 These amounts combined with estimates of prescription
`drug prices for 2002 and 2003 suggest that rebates on average provided a 7 percent
`discount in these years.32 A separate review of information on rebates from the financial
`filings of four branded pharmaceutical companies suggests that in 2011, rebates ranged
`from 8 percent to 33 percent of their wholesale sales.33
`In addition to the rebates provided to private TPPs, brand manufacturers also give
`rebates to the Medicaid program (known as OBRA rebates after the Omnibus Budget
`Reconciliation Act of 1990 that introduced them). OBRA rebates are calculated based
`on federal formulae, and for branded drugs they are structured so that Medicaid gets
`the benefit of the best discount available to private TPPs. In addition to OBRA rebates,
`states often sign supplemental rebate agreements with drug manufacturers, which allow
`them to further reduce their total drug costs. The OBRA rebate for branded drugs is
`calculated as the greater of 23.1 percent of the average manufacturer price (AMP) or the
`difference between AMP and the best price offered to any private payor.34 In addition,
`if the AMP of a drug grows faster than the consumer price index, this “extra” growth is
`further rebated to Medicaid. A 2005 CBO study estimated that brand manufacturers paid
`OBRA rebates averaging 31.4 percent of the average manufacturer’s AMP in 2003.35
`OBRA rebates for generic drugs are equal to 13 percent of AMP and are thus sig-
`nificantly smaller than OBRA rebates for branded drugs.36 Generic manufacturers do
`not offer rebates to private TPPs because TPPs have little control over which generic
`version of a drug gets dispensed by a pharmacy.
`Free samples also affect the total cost of branded drugs. For example, a consumer
`who receives a 10 day supply of free samples and whose course of treatment lasts thirty
`days effectively saves one third of the expenditures on the drug. The available data in-
`dicate that free samples, if valued at retail prices, were equal in value to approximately
`8-9 percent of spending in the U.S. on branded drugs between 2001 and 2004.37 This
`30 How Increased Competition from Generic Drugs Has Affected Prices and Returns in the Pharma-
`ceutical Industry, Congressional Budget Office, July 1998, at Appendix B. Note that best price measures
`the price available to a single purchaser. Average price net of rebates across all private purchasers is likely
`larger than the best price.
`31 Pharmacy Benefit Managers: Ownership of Mail-Order Pharmacies, Federal Trade Commission,
`August 2005, at viii.
`32 A study by Takeda found average retail price of branded drug prescriptions to be $79.80 in 2002 and
`$91.77 in 2003 (Prescription Drug Benefit Cost and Plan Design Survey Report, Takeda Pharmaceuticals,
`(2005) at 4).
`33 The companies are GlaxoSmithKline, Pfizer, Johnson & Johnson, and AstraZeneca. The percent-
`ages would be smaller if taken as a percent of retail sales. Rebates include rebates to Medicaid and other
`government programs and rebates to managed care and other health insurance programs. Do more, feel bet-
`ter, live longer: GlaxoSmithKline Annual Report for Shareholders, GlaxoSmithKline plc, 2011, at 59; 2011
`Financial Report, Appendix A, Pfizer, Inc., 2011, at 18–19; Form 10-K for the fiscal year ended 01/01/12,
`Johnson & Johnson, February 2012, at 34 and 56; AstraZeneca Annual Report and Form 20-F Information
`2011, AstraZeneca plc, 2011, at 94.
`34 The minimum OBRA rebate for branded drugs increased to 23.1 percent from 15.1 percent of the
`AMP as a result of the 2010 Patient Protection and Affordable Care Act.
`35 The Rebate Medicaid Receives on Brand-Name Prescription Drugs, Congressional Budget Office,
`June 2005, at 5.
`36 Similarly to the OBRA rebates for branded drugs, rebate for generic drugs increased to 13 percent
`from 11 percent of the AMP as a result of the 2010 Patient Protection and Affordable Care Act.
`37 The retail value of samples is from IMS Health IPS data as reported in Impact Of Direct-To-Consumer
`Advertising On Prescription Drug Spending, Kaiser Family Foundation, (June 2003); Prescription Drug
`Trends Update, Kaiser Family Foundation, (October 2004); Marc-Andre Gagnon & Joel Lexchin, The Cost
`of Pushing Pills: A New Estimate of Pharmaceutical Promotion Expenditures in the United States, 5 PLOS
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`corresponds to an average effective price discount from free samples of 7-8 percent.38
`Generic manufacturers do not provide free samples because physicians and patients do
`not control which generic version a pharmacy decides to stock and dispense. There is,
`therefore, no corresponding sample discount on generic drugs.
`
`iV. tHE EFFEcts OF GEnEric Entry On
`cOMPEtitiOn anD cOnsUMEr wELFarE
` To understand how consumer welfare is affected by generic competition it is neces-
`sary to understand how generics and brands compete. A key component of this compe-
`tition is how free riding by generics affects brands’ incentives to continue to compete
`with other brands through the promotion of their products and through investments to
`gain FDA approval for additional indications for their products. It is also necessary to
`understand the price discounts provided by generics, and in particular, how generic
`prices compare to the price the brand would charge absent generic entry and net of
`rebates and discounts from samples.
`A. The Nature Of Competition In Pharmaceutical Markets
`Generic competition in U.S. pharmaceutical markets has increased dramatically
`since the passage of the Hatch-Waxman Act in 1984.39 The Act significantly reduced
`generic entry barriers by allowing generic manufacturers to receive approval from the
`FDA without reproducing the expensive and time-consuming clinical trials required of
`branded drugs.40 In addition, states have increasingly adopted pharmacy substitution laws
`that allow (and sometimes even mandate) pharmacies to substitute generic equivalents
`of branded drugs without having to receive permission from the